Stocks Rebound at a Key Trendline

After dramatically breaking down the past two weeks, stocks this week more than found their footing in a textbook case of technical analysis and program trading. Technical analysis looks at supply and demand data in the form of price and volume for clues as to the direction of the trend, strength of the trend, etc. Technical analysts use rolling (aka “moving”) averages of price to create trendlines. Certain trendlines have become key reference points for stock prices. For example, the 20-day, 50-day, and 200-day moving averages are common reference points for short-term, intermediate-term, and long-term trends. With the ability to program computers to trade based on certain information (e.g. “program” trading), these trendlines can become self-fulfilling inflection points. The recent plunge in stock prices ran hard to visit the 200-day trendline – shown as the black line on Chart 1 below. At that point, computer buy programs clearly kicked in and bought the stock market (circled area). Stocks reversed upward and haven’t looked back. Take a look:

Chart 1: The 200-day moving average halts the market’s decline

The confounding thing for many investors in the stock market is that nothing else appeared to change, outside the price of the stock market hitting this trendline. Stocks were presumed to be falling hard for two weeks based on rising interest rates and fears of ramping inflation. However, only days later, an economic report seemingly confirming that inflation is indeed rising had no impact whatsoever on stocks. The market rose strongly despite the report. If the rebound holds, it will be assumed that investors simply needed the fresh cleansing that a correction in prices (defined as a -10% decline, at least) brings. The correction creates perceived value in the market where none may have existed for some time. Until this month, the stock market had gone two years without a correction. That’s a long time in between cleansings! Now, to see if the rebound holds. Or if the rebound tempts another round of selling, and another test whether the computers buy the stock market once more at the trendline.

Market Update

Stocks entered the week looking to build on a sharply positive market reversal from the Friday prior. That reversal took the S&P 500 from being down -2% to closing up by +1.5%. The rebound continued Monday with a +4% gain in Apple (AAPL) sparking the indexes to a +1.4% result. Weakness at Tuesday’s market open was overcome by day’s end with markets adding another +0.3%. Wednesday found stocks down -1% just before the open on an inflation report that was higher than expected. That report sent interest rates upward to 2.9% on the 10-year Treasury bond. However, investors swooped in to buy the dip and drive stocks up +1.3%. Stocks added a fifth straight gain Thursday fueled in part by a strong earnings report from Cisco Systems (CSCO). The S&P 500 rose +1.2% to reclaim its 50-day moving average. Friday afternoon was choppy, but the S&P 500 finishing slightly up posted its sixth consecutive win.

Investors reversed course this week, buying the market drop and sending the S&P 500 (SPY) higher by +4.46% to recover almost all of the prior week’s sharp tumble. The Nasdaq 100 (QQQ) surged +5.68% while the small-cap Russell 2000 (IWM) recovered +4.11%.